Marginal Productivity Theory of Factors of Production
The marginal productivity theory of factors of production is a concept in economics that explains how the price of factors of production, such as labor and capital, is determined in a competitive market. According to this theory, the price of a factor of production is determined by its marginal productivity, which is the additional output that is generated by employing one more unit of the factor.

Explanation of Price Determination Process
- Law of Diminishing Marginal Returns: According to this law, as more units of a factor of production are employed, the marginal productivity of that factor will eventually decrease. This means that each additional unit of the factor will contribute less to total output.
- Equilibrium Price: In a competitive market, factors of production are paid according to their marginal productivity. If the price of a factor is higher than its marginal productivity, firms will reduce their demand for that factor. On the other hand, if the price is lower than the marginal productivity, firms will increase their demand.
- Market Forces: The interaction of supply and demand for factors of production in the market will eventually lead to an equilibrium price, where the price of the factor equals its marginal productivity. This ensures that resources are allocated efficiently in the economy.
- Implications: The marginal productivity theory of factors of production helps in understanding how wages, rents, and other factor prices are determined in a competitive market. It also highlights the importance of productivity in determining the income earned by factors of production.
In conclusion, the marginal productivity theory of factors of production is a fundamental concept in economics that explains the relationship between the price of factors of production and their contribution to total output.